Rothwell v. Chubb

• Court: District Court, D. New Hampshire
• Decided: March 31, 1998
• Docket: CV-96-83-B
• Status: Published

Opinion

Rothwell v. Chubb CV-96-83-B 03/31/98

UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW HAMPSHIRE

Donald E. Rothwell, et al.

v. Civil No. 96-83-B

Chubb Life Insurance Company of America

MEMORANDUM AND ORDER

Donald Rothwell, Joseph Buddemeyer, Florence Landau, and

Stanley Landau charge in their class action complaint that Chubb

Life Insurance Company of America ("Chubb") implemented a scheme

to induce prospective policyholders to purchase interest-

sensitive whole life or universal life insurance policies through

the use of fraudulent and deceptive sales practices. Two of

plaintiffs' claims are based on alleged violations of the

Securities Act of 1933, 15 U.S.C.A. § 77 et seq. (West 1997).

Chubb seeks summary judgment with respect to both claims, arguing

that the policies at issue are not regulated as securities under

the Act. As I agree, I grant the motion for partial summary

judgment.1

1 I address plaintiffs' motion for class certification in a separate order. I.

The insurance policies at issue in this case require the

policyholder to pay a set premium in exchange for Chubb's promise

to pay a guaranteed death benefit. For example, plaintiff

Rothwell's policy guarantees him a $50,000 death benefit for the

first five years and a death benefit of at least $21,869 for each

year thereafter in exchange for an annual premium of $832.

Premium payments, after the cost of insurance and various other

charges are deducted, are credited to a "Fund Account," the

balance of which grows over time. The Fund Account earns

interest at a rate guaranteed for the first year. Although

Chubb thereafter may adjust the interest rate up or down, the

rate may not fall below a guaranteed minimum level.

The Fund Account serves several functions. A policyholder

may borrow against the Account or reclaim the balance in the

Account, less any surrender charge, by canceling the policy.

As the balance in the Account grows over time, the additional

amount required to satisfy the specified death benefit corres­

pondingly diminishes, reducing the policyholder's cost of

insurance. Depending upon the value of the Account and the

designated interest rate, the Account may generate sufficient

interest to reduce or even eliminate the need for additional

out-of-pocket premium payments. Alternatively, after the initial period during which the maximum death benefit is guaranteed,

Chubb may reduce the death benefit if the interest generated on

the Account is not sufficient in conjunction with the premium

payments to fully cover the cost of insurance.2

Plaintiffs' primary argument is that Chubb adopted a

practice of encouraging its agents to make misleading statements

to prospective policyholders concerning the point at which the

interest generated on the Fund Account would be sufficient to

eliminate the need for future out-of-pocket premium payments.

According to the complaint, Chubb sold its policies through the

use of computer-generated illustrations demonstrating this

"vanishing premium" feature. These illustrations, tailored to

the individual financial situation of each prospective policy­

holder, predicted the performance of the policy based on an

assumed interest rate. The rate assumed in the illustrations

typically was the initial rate guaranteed in the first year, but

in no event was it greater than the rate at which Chubb had

2 In the event that the interest earned on the Fund Account is insufficient in conjunction with the premium payments to cover the cost of insurance, the policyholder also has the option of either retaining the initial death benefit by paying a higher premium payment or, if the value of the Fund Account is above a specified level, paying the initial premium amount, retaining the initial death benefit, and making up the difference from principal.

3 credited policies in the previous year. The illustrations showed

that if the interest rate Chubb used in crediting the Fund

Account remained at the assumed level, the policyholder's out-

of-pocket premium payments would cease after a given term of

years and the policyholder's death benefit would remain for the

life of the policy at the level guaranteed for the first five

years.

Plaintiffs contend that such illustrations were uniformly

misleading in that they failed to adeguately disclose, inter alia

that: (1) the assumed interest rates were unrealistically high;

(2) incremental changes in the assumed interest rates could

extend the "vanish year"; (3) a significant change in the assumed

rate could mean that the "vanish year" would never be reached;

and (4) changes in other undisclosed assumptions could reguire

the policyholder to continue making premium payments for many

years after the "vanish year" depicted in the illustrations.

Plaintiffs also claim that Chubb's agents failed to make

additional disclosures that were necessary to render the

illustrations not misleading.

Plaintiffs also allege that Chubb orchestrated a "churning"

scheme by which it induced thousands of persons who already owned

life insurance to use the accumulated cash value in their

4 existing policies to purchase new policies with Chubb. Chubb's

agents allegedly represented to policyholders that by using the

accumulated cash value in their existing policies, they could

obtain new policies offering greater coverage with no additional

premium outlays. In many cases, however, the cash values

borrowed or taken from the pre-existing policies proved insuf­

ficient to cover the premiums for the new policies. Rather, many

policyholders had to make additional premium payments, often in

increased amounts, in order to maintain coverage. Additionally,

policy replacement often entailed significant undisclosed

administrative fees and sales commissions.

Plaintiffs contend that the life insurance policies at issue

in this case are unregistered securities sold in violation of

section 12(1) of the Securities Act. Section 12(1) states that

"any person who offers or sells a security in violation of [the

Act's registration provisions] . . . shall be liable . . . to the

person purchasing such security from him." 15 U.S.C.A. § 771(1).

Additionally, plaintiffs contend that in using deceptive sales

practices to sell these "securities," Chubb violated section

12(2) of the Securities Act, which makes liable any person who

"offers or sells a security . . . by means of a prospectus or

oral communication, which includes an untrue statement of a

5 material fact or omits to state a material fact necessary in

order to make the statements . . . not misleading." 15 U.S.C.A.

§ 771(2) .

In order to establish that plaintiffs are entitled to relief

under these provisions, they must demonstrate that the insurance

policies they purchased are "securities" as defined by the

Securities Act. Contending that plaintiffs' insurance policies

are not securities, Chubb moves for summary judgment on both

Securities Act claims.

II.

Summary judgment is appropriate only "if the pleadings,

depositions, answers to interrogatories, and admissions on file,

together with the affidavits, if any, show that there is no

genuine issue as to any material fact and that the moving party

is entitled to a judgment as a matter of law." Fed. R. Civ. P.

56(c); see Lehman v. Prudential Ins. Co. of Am., 74 F.3d 323, 327

(1st Cir. 1996). A genuine issue is one "that properly can be

resolved only by a finder of fact because [it] . . . may reason­

ably be resolved in favor of either party." Anderson v. Liberty

Lobby, Inc., 477 U.S. 242, 250 (1986) . A material fact is one

that affects the outcome of the suit. Id. at 248. In ruling on

6 a motion for summary judgment, the court construes the evidence

in the light most favorable to the non-movant and determines

whether the moving party is entitled to judgment as a matter of

law. Oliver v. Digital Equip. Corp., 846 F.2d 103, 105 (1st Cir.

1988) .

Where the nonmoving party bears the burden of persuasion at

trial, it must "make a showing sufficient to establish the

existence of [the] element[s] essential to [its] case" in order

to avoid summary judgment. Celotex Corp. v. Catrett, 477 U.S.

317, 322 (1986) . It is not sufficient to "rest upon mere

allegation[s] or denials of [the nonmoving party's] pleading."

LeBlanc v. Great Am. Ins. Co., 6 F.3d 836, 841 (1st Cir. 1993)

(guoting Anderson, 477 U.S. at 256). Rather, to establish a

trial-worthy issue, there must be enough competent evidence "to

enable a finding favorable to the nonmoving party." Id. at 842

(internal citations omitted).

Plaintiffs argued in their objection to Chubb's summary

judgment motion that summary judgment should be denied both

because issues of material fact remain in genuine dispute and

because the motion is premature in that they have not yet had

discovery on the merits of their claims. At oral argument,

however, plaintiffs' counsel was given the choice of meeting

7 defendant's motion head-on or making a motion for further

discovery pursuant to Fed. R. Civ. P. 56(f). At that time,

plaintiffs waived any recourse to Rule 56(f). Therefore, I

consider whether plaintiffs' proffer as to the security status of

their life insurance policies is sufficient to withstand summary

judgment.3

III.

A. LAW

1. The Securities Act

The Securities Act omits any reference to insurance policies

when defining the term "security." See 15 U.S.C.A. § 77b(a)(1).

This omission is no oversight, as section 3(a)(8) of the

Securities Act expressly exempts from treatment as a security

"[a]ny insurance or endowment policy or annuity contract or

optional annuity contract, issued by a corporation subject to the

3 The fact that a motion for class certification is pending does not prevent me from ruling on the summary judgment motion before determining whether to certify the class. "'There is nothing in Rule 23 which precludes the court from examining the merits of plaintiff[s'] claims on a proper . . . Rule 56 motion for summary judgment simply because such a motion' precedes resolution of the issue of class certification." Schweizer v. Trans Union Corp., No. 97-7542, 1998 WL 49163, at * 5 (2d Cir. Jan. 26, 1998) (guoting Lorber v. Beebe, 407 F. Supp. 279, 291 n.ll (S.D.N.Y. 1976)); Thompson v. County of Medina, 29 F.3d 238, 240-41 (6th Cir. 1994).

8 supervision of the insurance commissioner . . . of any State or

Territory of the United States or the District of Columbia."

Id. § 77c(a)(8). As Congress explained, section 3(a)(8) "makes

clear what is already implied in the act, namely that insurance

policies are not to be regarded as securities subject to the

provisions of the act. The entire tenor of the act would lead,

even without this specific exemption, to the exclusion of

insurance policies from the . . . act." H.R. 73-85, at 15

(1933) .4

4 The Securities Act's anti-fraud provisions, sections 12(2) and 17, expressly provide that they apply to even those instruments exempt under section 3. 15 U.S.C.A. §§ 771(2), 77q(c). Since the Securities Act's enactment, however. Congress, the SEC, courts, and commentators have taken the view that section 3(a)(8) is surplusage that merely reiterates what section 2(1) implies, that insurance policies are not securities for any purpose under the Act. See, e.g., Tcherepnin v. Knight, 389 U.S. 332, 342 n.30 (1967) ("[T]he exemption from registration for insurance contracts was clearly supererogation.") (citing SEC v . Variable Annuity Life Ins. Co. of Am., 359 U.S. 65, 74 n.4 (1959)); Berent v. Kemper Corp., 780 F. Supp. 431, 440-41 (E.D. Mich. 1991) ("Insurance policies that come within Section 3(a) (8) are excluded from the anti-fraud provisions of all federal securities laws."); Louis Loss & Joel Seligman, Fundamentals of Securities Regulation 208 (3d ed. 1994) ("[T]he [SEC] early on took the position that insurance . . . policies were not intended to be securities, and that in effect § 3(a)(8) is supereroga­ tion."); Securities Act Release No. 33-6558, 49 Fed. Reg. 46750, 46753 (Nov. 28, 1984) ("[T]here can be no serious question that Congress intended any insurance contract . . . falling within section 3(a)(8) . . . to be excluded from all provisions of the Act, notwithstanding the plain language of the Act that section 3(a) (8) is an 'exemption' from the registration but not the antifraud provisions."). Consequently, I use the same standards

9 The Supreme Court has explained that the exclusion of

insurance policies from coverage reflects that, at the time the

Securities Act was passed, there was

a form of "investment" known as insurance (including "annuity contracts") which did not present very sguarely the sort of problems that the Securities Act . . . (was) devised to deal with, and which were, in many details, subject to a form of state regulation of a sort which made the federal regulation even less relevant.

SEC v. United Benefit Life Ins. Co., 387 U.S. 202, 210 (1967)

(guoting SEC v. Variable Annuity Life Ins. Co. of Am., 359 U.S.

65, 75 (1959) ("VALIC") (Brennan, J., concurring)). Since that

time, the insurance industry has grown increasingly dynamic,

offering new products that resemble securities more closely than

the traditional forms of insurance. See VALIC, 359 U.S. at 75-6

(Brennan, J., concurring). Accordingly, simply labeling as

"insurance" what otherwise would be considered a security is not

sufficient to ensure an instrument's exemption from the provi­

sions of the Act. Id.; Associates in Adolescent Psychiatry v.

Home Life Ins. Co., 941 F.2d 561, 566 (7th Cir. 1991), cert.

denied, 502 U.S. 1099 (1992) ("Associates"). Rather, for a

novel insurance product to avoid security status as an exempt

"insurance policy", it must resemble the sort of investment form

to evaluate both plaintiffs' section 12(1) and 12(2) claims.

10 that Congress intended to exclude from coverage. United Benefit,

387 U.S. at 210; VALIC, 359 U.S. at 75 (Brennan, J., concurring).

The Supreme Court first sguarely addressed this subject in

VALIC. At issue was a type of variable annuity contract under

which purchasers' premium payments were pooled in a separate fund

and invested. 359 U.S. at 69. Purchasers were entitled to a pro

rata share of the Fund which, as the Court noted, "may be a lot,

a little, or nothing" depending upon the success of the issuer's

investment strategy. Id. at 71. Because the issuer assumed no

risk under the variable annuity contract, the Court held that the

contract was not exempt from regulation under the Securities Act.

Id.

The Court next ruled in United Benefit that an insurer

cannot exempt a variable annuity contract from regulation under

the Securities Act merely by providing a low guaranteed minimum

rate of return. 387 U.S. at 212. In that case, the issuer

pooled purchasers' premium payments in a separate fund for

investment but guaranteed purchasers a low minimum rate of

return. Id. at 205-06. Whether a purchaser could receive

payments above the guaranteed rate depended upon the fund's

investment success and could not be determined until after the

purchaser's right to recovery matured. Id. In holding that the

11 annuity was subject to regulation as a security, the Court stated

that because the annuity's guaranteed rate of return was sub­

stantially lower than those guaranteed by conventional annuities,

purchasers essentially relied on the investment skill of the

issuer to provide the bulk of the return. Id. at 209-09.

Finding that the contracts thus were devised to appeal to the

purchaser not on "the usual insurance basis of stability and

security but on the prospect of 'growth,'" the Court concluded

that the annuity was not exempt from coverage under the Act.

Id. at 210-11.

2. SEC Safe Harbor

In 1986, the SEC adopted Rule 151, creating a "safe harbor"

that codified the existing state of the law under section

3(a) (8) .5 Securities Act Release No. 33-6645, 51 Fed. Reg. 20254

(May 29, 1986); Thomas L. Hazen, The Law of Securities Regulation

§4.9, at 198 (3d ed. 1995). Although the rule is directed at

annuities, it applies with egual force to insurance policies.

5 Rule 151 does not establish "an all-inclusive definition purporting to encompass every annuity [or insurance contract] that falls within the section 3(a)(8) exclusion." Securities Act Release No. 33-6645, 51 Fed. Reg. at 20255. Rather, the rule defines a class of instruments that the SEC believes to be clearly covered by section 3(a)(8). Id. Conseguently, even a contract that does not fall precisely with the scope of Rule 151 may still be exempted from treatment as a security under section 3 (a) (8) . Idj.

12 Securities Act Release No. 33-6645, 51 Fed. Reg. at 20255 n.4.

Under Rule 151, an annuity or insurance policy is exempt under

section 3(a)(8) if: (1) the contract is issued by an insurer

subject to the supervision of the applicable state insurance

department; (2) "the insurer assumes the investment risk under

the contract"; and (3) the contract "is not marketed primarily as

an i n v e s t m e n t 17 C.F.R. § 230.151(a) (l)-(3) (1997). The

insurer is said to assume the investment risk if: (1) "the

value of the policy does not vary according to the investment

experience of a separate account"; (2) the insurer guarantees the

premium payments and credits the account at an interest rate at

least egual to the minimum rate reguired by state law; and (3)

the insurer guarantees that it will not change the rate of

interest to be credited in excess of the minimum guaranteed

rate more freguently than once per year. Id. § 230.151(a) (2)

& (b) (1) - (3) .

Because plaintiffs' policies were issued prior to the

promulgation of Rule 151, the rule does not control the dis­

position of this case. See Associates, 941 F.2d at 565 ("Only

persons who rely on a regulation may claim benefit of its safe

harbor."). Rather, I decide this case based on section 3(a)(8)

and interpretive case law. See id. Because the SEC promulgated

13 Rule 151 in response to, and as a codification of, the case law

interpreting section 3(a) (8), however, reference to the rule may

facilitate my analysis. See id.; Otto v. Variable Annuity Life

Ins. C o ., 814 F.2d 1127, 1133 (7th Cir. 1986); Securities Act

Release No. 33-6645, 51 Fed. Reg. at 20261 ("The rationale

underlying the conditions set forth in [Rule 151] is relevant

to any section 3(a) (8) determination.").

B. ANALYSIS

The policies at issue address two types of risk: insurance

risk and investment risk. The insurance risk, the risk that the

policyholder will die prematurely, is born entirely by Chubb.

Chubb accounts for this risk in the traditional manner by using

actuarial calculations about life expectancy to determine the

cost of a given amount of insurance for a particular insured.

The investment risk, the risk that principal will be lost and/or

that the return on investment will be lower than expected, is

shared by Chubb and its policyholders. Chubb guarantees princi­

pal, provides a minimum guaranteed rate of return, specifies a

guaranteed excess interest rate for the first year that the

policy is in effect, and agrees thereafter to announce changes in

the excess rate prospectively. Chubb's policyholders assume the

risk that the excess interest rate will fall after the first

14 year.6 The question thus presented is whether the interest risk

retained by Chubb's policyholders is sufficient, in view of the

other risks born by Chubb, to prevent the policies from being

considered under the Securities Act's insurance exemption. The

answer to this question is no.

Chubb's policies have three attributes that lead me to the

conclusion that they are not subject to regulation under the

Securities Act. First, the policies guarantee a minimum interest

rate of 4%. Although this rate is relatively low, it exceeds the

minimum rate required by the nonforfeiture laws of the states in

which plaintiffs purchased their policies, see Md. Code Ann.,

Ins., § 16-504 (WESTLAW through 1997 Sess.) (requiring minimum

rate of 3%); NY Ins. Law § 4223 (McKinney, WESTLAW through 1997

Sess.) (same), as well as the minimum rate required for

individual annuity contracts by the National Association of

Insurance Commissioners Standard Nonforfeiture Law, see NAIC 805-

1 (WESTLAW 1997). Accordingly, the 4% rate is consistent with

6 The policies at issue authorize Chubb to adjust the death benefit after a period of time if the premium payments plus the interest generated on the Fund Account do not generate sufficient income to fund the cost of the initial death benefit. This policy feature does not shift any insurance risk onto the policyholder. Rather, it merely reflects the fact that reductions in the interest rate paid on the Account could impair the ability of the Account to generate sufficient interest to fund the cost of the initial death benefit.

15 the minimum guaranteed rate required by Rule 151's safe harbor.

See 17 C.F.R. § 230.151 (b) (ii) and (c) .

Second, Chubb assumes significant investment risk by

declaring any changes to the excess interest rate only

prospectively. Annuity contracts such as those at issue in VALIC

and United Benefit, where the insurer holds the policyholders'

money for a time before announcing the interest rate at which it

will credit the money, permit an insurer to reflect upon its

investment experience and set the rate so that its payment

obligations will not exceed its own investment return. See

Associates, 941 F.2d at 566-67 (citing Otto, 814 F.2d at 1140-42;

Peoria Union Stock Yards Co. Retirement Plan v. Penn Mut. Life

Ins. C o ., 698 F.2d 320, 324-25 (7th Cir. 1983)). Under such an

arrangement, the insurer truly does shift the investment risk to

the policyholders. See id.; Harper-Wvman Co. v. Connecticut Gen.

Life Ins. Co., No. 86 C 9595, 1991 WL 285746, at *4 (N.D. 111.

Dec. 23, 1991). The policies at issue in this case, however,

require Chubb to predict the future performance of its

investments and prospectively set the rate at which it will

credit the Fund Accounts. Once Chubb has declared an interest

rate, it assumes the risk that, despite its predictions, its

investments will not perform sufficiently to meet its obligation

16 to pay at the declared rate. See Associates, 941 F.2d at 567;

Harper-Wvman, 1991 WL 285746, at *4. Additionally, advance

notice of rate changes gives plaintiffs a meaningful opportunity

to assess whether they wish to continue to hold their policies.

See Associates, 941 F.2d at 567. This arrangement thus limits

the extent to which investment risk is placed upon the

policyholders. See id.

Finally, Chubb has offered unrebutted evidence that it does

not change the excess interest rate more freguently than once per

year.7 Conseguently, these are not policies under which the

insurer shifts investment risk onto the policyholder by

exercising unfettered discretion to continually adjust the

7 Nowhere in plaintiffs' policies is Chubb expressly barred from changing the excess interest rate more freguently than once per year. Conseguently, the security status of the policies under Rule 151 is guestionable. See 17 C.F.R. § 230.151(b) (3) (safe harbor applies only where insurer guarantees it will not change excess rates more freguently than once per year). Chubb has submitted evidence, however, that in practice it does not change the excess interest rate more freguently than once per year. Plaintiffs offer nothing to rebut this showing. Conseguently, the only reasonable inference the current state of the evidence permits is that Chubb does not, in fact, change the excess interest rate on plaintiffs policies more freguently than once per year. See Anderson, 477 U.S. at 250 (to withstand summary judgment, non-movant must set forth evidence that would enable finder of fact to find in its favor); LeBlanc, 6 F.3d at 841.

17 interest rate so as to ensure that its investment returns are

always sufficient to cover its obligations. See Associates, 941

F.2d at 567-68; Otto, 814 F.2d at 1140-42; Securities Act Release

No. 33-6645, 51 Fed. Reg. at 20258. Rather, when Chubb declares

a new excess interest rate, it expressly assumes the risk that

its investments will earn insufficient income over the next year

to cover its obligations. See Associates, 941 F.2d at 567.

Given this feature, the policies do not place excessive invest­

ment risk on plaintiffs. See id.; Berent v. Kemper Corp., 780

F. Supp. 431, 443 (E.D. Mich. 1991); Securities Act Release No.

33-6645, 51 Fed. Reg. at 20258.

Both sides agree that Chubb is subject to regulation by the

insurance commissioners of the states in which it issued its

policies. Further, the undisputed evidence demonstrates that

Chubb has assumed all of the insurance risk and most of the

investment risk arising from the policies at issue. Although

the policies leave the policyholder with the risk that Chubb will

lower the excess interest rate after the first year, that risk is

tempered by an adeguate minimum guaranteed interest rate and by

the knowledge that the interest rate will be adjusted only pro­

spectively and not more freguently than once a year. Under these

circumstances, the policies do not place excessive investment

18 risk on the policyholder. Nor will the record permit a finding

that the policies at issue were devised to be sold primarily as

an investment. Accordingly, the policies are exempt from

regulation under the Securities Act.

IV.

For the reasons stated herein, I grant Chubb's motion for

partial summary judgment (document no. 50).

SO ORDERED.

Paul Barbadoro Chief Judge

March 31, 1998

cc: Paul Maggiotto, Esg. Peter Lagorio, Esg. Mark Weaver, Esg. Jeffrey Barist, Esg. Charles J. Piven, Esg. Richard S. Schiffrin, Esg. Michael D. Craig, Esg.